When Picking Mutual Funds, Follow The Money: S&P

The 1976 film “All the President’s Men” made famous the line "follow the money" and inspired an entire generation of muckraking journalists. Now some analysts at Standard & Poor's are saying their research shows this philosophy could also serve as a good starting point for identifying strong-performing mutual funds.

In a report titled Follow the Mutual Fund Money Flow, the report's authors conclude that "one of the central tools for surmising investor sentiment is money flow -- the rate that money is going in and out of a financial investment."

Money flow analysis, they suggest, can “help investors decide whether it is a good time to invest in one peer group of mutual funds or another.”

To test their thesis, the researchers looked at mutual fund peer groups that had the most money inflows year to date in 2011, using the Lipper Fund Flows Database, which looks at weekly investor flow trends on some 19,000 open-end mutual fund share classes with an aggregate asset base of $11 trillion.

Their conclusion: the domestic natural resources group had the largest inflow as a percentage of total assets, at 11% over the period. They note that it was the only sector to register a double-digit increase in cash inflows, and that it beat the No. 2 peer group, basic materials, by three percentage points.

Of the 66 mutual funds in the domestic natural resources sector, they settled on two funds that had five-star S&P ratings. These were ICON Energy Fund (ICENX) and Vanguard Energy Fund (VGENX).

ICON Energy has 89% of its holdings in energy, with minor positions in industrials and information technology. The top two holdings in the fund are Exxon Mobil and Chevron, which together account for 37% of assets. Other top holdings were also in the oil sector. It had a 4.69% return year to date, nearly double the peer group average of 2.52%.

The Vanguard Energy Fund, which showed a 7.11% return year to date compared to a negative 1.06% return for its peer group, has 92% of its holdings in the energy sector, with top holdings also including Exxon Mobil and Chevron, though those two stocks only represent 12% of total assets.

Report author Ari Bensinger cautions that following the money as a strategy always carries the risk that investors could be “chasing past performance,” but he says, “There is nonetheless a correlation between past performance and future continued performance.”

He says the idea is only to use the “follow the money” theme as an initial screen. “Then you have to look at individual fund performance, market conditions, and so on.”

Asked whether following the money also made sense as a strategy for getting out of certain sector mutual funds, Bensinger said, “Sure, it could also work in reverse.”